What Do Banks Do When They Don’t Lend?

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This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Banks are not lending much
-Consumers not borrowing much
-What will banks do with excess capital?
 

By Eva Brocklehurst

"We've got the money. We're in the money…" goes an old advertisement. Granted, it wasn't a bank singing the song but today it should be. Australia's banks have the money so why aren't they lending? Is it because borrowers are not fronting up in droves to beg for funds like they once did? Are the banks still keeping a tight leash on credit, even though their books are sound, impairments are stabilising and low interest rates have restored margins? Analysts have pondered the situation at length.

As our story earlier this week revealed, Australian banking shares are sought after, high yielding investments so the share prices have gone up and up … and up. Many brokers believe they may now be too expensive and losing sight of the fundamentals. Banking business is not growing. The time is right for households and business to start asking for money but so far they've been reluctant. Witness the February lending figures from the Reserve Bank. If banks are not lending then there is little growth to be had from that quarter. Maybe banks have to keep more money on hand these days.

Macquarie cites remarks about capital requirements by the Australian regulator's (APRA) John Laker recently. He said the appropriate level of capital needs to be more nuanced and forward looking than just covering prudential requirements. Perhaps the banks fear they're not out of the GFC woods yet. Dr Laker made the point that this need should be kept in mind when the market starts clamouring for special dividends, buybacks etc. So, be warned. Macquarie also notes the banking sector globally is being required to be more conservative and be more comparable across jurisdictions. In Australia's case it may be a case of when the going gets conservative the conservative get going.

A further look at capital adequacy and risk weighting has Macquarie pondering inconsistencies among Australia's major banks. Looking at the risk weighting for mortgages the broker finds Westpac ((WBC)) has 58% of mortgages with a risk weighting less than 15%, followed by National Australia Bank ((NAB)) with 61%, Commonwealth Bank ((CBA)) with 66% and ANZ Banking ((ANZ)) with 74%. Citing Sweden and Hong Kong, which have set minimum risk weightings of 15%, Macquarie looks at what would be required to lift the risk weighting throughout to that level here and finds the majors would fall short on minimum capital levels as defined by APRA. Amidst an ongoing debate on this subject, the broker concludes that a capital return by the banks at this point would not be prudent. Macquarie suggests a 'wait and see' approach to the banks' excess capital intentions but believes this perceived excess capital has supported the share price appreciation in recent months.

Macquarie has divided the four pillars of Australia's banking system into two divisions based on their book mix – the predominantly retail bankers are CBA and WBC and predominantly business bankers are NAB and ANZ. In doing so, the broker believes the premium that the retail banks generally command has peaked. There are now more opportunities for business banking as home mortgage growth remains slow and there is little room for re-pricing. The price earnings premium peaked at two points recently (usually averaging one point) as mortgage margins were restored, but the broker thinks this will erode as impairments stabilise and business rediscovers debt. Hence, NAB and ANZ become the brokers favourites, for now.

UBS notes households are still afraid of being in hock, citing housing finance credit at a record low in February. Digging into this the analysts found that the weakness was all to do with owner occupiers. Investors were starting to borrow to invest in housing again, attracted by the low interest rates and a tight rental market. Maybe households just need more time. Some would be priced out of the mortgage market by rising house prices but, in BA-Merrill Lynch's analysis, the debt burden is still pretty high. The broker notes falling interest rates have steadied the escalation in household debt and it has returned to late 2004 levels. Moreover, in terms of house prices Merrills notes, while they are recovering, they're not back to previous highs. The house price to household income ratio has improved. So, maybe it's all about a much more level-headed market.

Another hindrance to a willingness to borrow could be the looming federal election. UBS believes businesses have likely put off borrowing until the political backdrop is more predictable. For BA-Merrill Lynch broad corporate health indicators are favourable but stresses in the system can rise up quickly. Tensions remain in the eurozone and this still has potential to develop into another financial crisis. Is this a reason for business caution? Merrills acknowledges the valuation of banks reveals low risk perceptions but then, when it comes to the broker itself picking preferred stocks, the UK connection (weakness) for NAB is cited as a reason for preferring ANZ and WBC. Moreover, Merrills finds shades of the past still hang over NAB in terms of asset quality and executing on its strategy. CBA is fourth in line and here the broker, too, has a problem justifying the valuation premium, given the low earnings growth.

Conservative banks, cautious households, subdued businesses …maybe it's all just a brave new world. A last word on whether the banks are overvalued. Macquarie notes, for the year-ending 28 March 2013, the major Australian banks outperformed the S&P ASX 200 by 16%. Yearly share price performance showed WBC up 40.6%, CBA 34.8%, NAB 23.4% and ANZ 21.6%. The S&P ASX 200 was up 14.5%.

See also Oz Banks Suffer Weak Credit Growth on April 3 2013 and Are Oz Banks Overvalued? on March 25 2013.
 

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